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GOLD REACHED A NEW high last week, climbing above $2,200 for the first time. Year-to-date, gold is up 8% and, since the end of 2021, it’s gained more than 20%, outpacing the S&P 500. This raises two questions: Can we expect the rally to continue? And does gold deserve a place in your portfolio?
To answer these questions, let’s start by looking at the drivers of the recent rally. The first factor is interest rates. While rates are still elevated, and the Federal Reserve has yet to cut its benchmark rate, it’s indicated its intention to do so soon. As a result, other rates have already started to drop. The yield on the 10-year Treasury note has edged down from almost 5% in October to 4.2% today. How do interest rates impact the price of gold? To understand the connection, think about it from the point of view of an investor with cash to invest.
Investments are, in a sense, all in competition with each other for investors’ dollars. Because gold doesn’t produce any income, it becomes relatively less attractive when investors can earn more elsewhere. When a simple U.S. government bond offers nearly 5%, gold looks much less appealing. But when interest rates start to come down, the scales begin to tilt back, and that’s what we’ve seen recently.
Another factor is geopolitical instability. There’s Russia’s ongoing attack on Ukraine, and terrorists seem to be striking with increasing frequency around the world, with attacks recently in Israel, Russia, Turkey, South Korea and Pakistan. Terrorists have also been attacking cargo ships off the coast of Yemen, disrupting a key global shipping lane. Uncertainty like this makes gold relatively more attractive, because it offers a safe haven that’s independent of any country or currency.
There are other reasons, too, for gold’s runup. According to a Wall Street Journal analysis, China’s central bank bought more gold last year than it had in any year since the 1970s. Consumer demand for gold in China has also been strong, with jewelry sales up nearly 25% during the recent lunar new year holiday season. Overall, China increased its gold imports by 51% in 2023. Why the sudden surge in popularity?
One reason is the weakness in China’s stock market, which dropped in 2021, 2022 and 2023, and is down again so far this year. China’s real estate market has also been going through a rough patch. With these investment options looking less appealing, gold has become relatively more attractive.
Putting these factors together, it looks like gold prices have a lot of support. Where will gold go from here? It’s hard to know. Gold doesn’t pay any income. As Warren Buffett likes to say, it “just sits there.” In fact, gold costs money to hold, because it requires storage space and security.
This is relevant because the cash flow that an investment generates provides investors with a tangible basis for valuing that investment—a concept known as intrinsic value. When an investment doesn’t generate any income, it’s very difficult to say what the right price should be, and that makes it much more unpredictable.
To be fair, gold isn’t the only investment lacking intrinsic value. Cryptocurrencies like bitcoin also lack intrinsic value. But the comparison with cryptocurrencies also highlights three unique aspects of gold. First is its long history. Archeologists have found evidence of gold being used in jewelry in Mesopotamia as much as 4,000 years ago. Gold is hardly a passing fad.
Second, gold is an internationally recognized store of value for governments. Indeed, for decades after World War II, under the Bretton Woods system, world currencies were pegged to the U.S. dollar, which—in turn—was pegged to gold at a fixed exchange rate. Though we’ve moved away from that system, central banks continue to hold vast reserves of gold.
Finally, gold has a number of industrial uses—in medical devices, in electronics and in aviation. For all these reasons, gold is a unique investment, and many feel it deserves a place in a diversified portfolio. For gold enthusiasts, the dynamics we’ve seen this year prove its value.
There is, however, another challenge gold bulls need to consider: You may notice that, so far, I’ve left out any mention of inflation. Because gold is a store of value that’s independent of any country or currency, many view it as an effective hedge against inflation. During the 1970s, for example, when annual inflation in the U.S. topped 12%, gold soared.
But we’ve seen gold do precisely the opposite over the past few years. In 2022, when inflation began to rise, gold fell. And in 2023, when inflation started to recede, gold rose. In other words, gold has run completely counter to expectations.
The bottom line: For investors, life would be easier if investments were more predictable—if we knew with certainty which factors would drive their prices up and down. For investments that carry intrinsic value, this dynamic exists to some degree. Look at a chart of the S&P 500-stock index, for example, and compare it to a chart of the earnings of the 500 companies in the index, and you’ll see they generally move in the same direction. Share prices follow profits.
Even so, the relationship is loose. That’s because there’s always more than one variable at work. Market sentiment, geopolitical news and other factors also drive share prices. And they can drive prices in the opposite direction from earnings. As a result, despite having intrinsic value, stock prices can still do anything in the short term.
When it comes to gold—where there’s no intrinsic value—the investor’s job becomes that much harder. As we’ve seen, some factors are positive for gold, while others are negative. But because there’s always a mix of factors at work at any given time, it’s impossible to know which will ultimately win out. For that reason, despite its recent gains, I continue to recommend against owning gold—except as jewelry.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
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You do a disservice to your readers when you do not mention that over the long term gold is not a good investment at all. Over the long term stocks outperform gold 3 to 1. https://www.investopedia.com/ask/answers/020915/has-gold-been-good-investment-over-long-term.asp
I appreciate this brief but informative article. Thank you.
I’ve always shied away from gold, mostly because of transaction and ongoing costs and also because of the fact that it can’t quickly be converted to dollars or another alternative currency when you really need to do that quickly. There are many alternative investments without those drawbacks. So I’d need gold to give me something extra to offset those drawbacks. It doesn’t do that for me.
To me, it is just one of 118 or so elements, one that happens to have a track record where a few important subgroups of mankind dating from ancient times thought it was special and thus worth more than other substances, in part because it was beautiful, in part because it seemed rare, and in part because when it did occur in nature, it could be found in relatively pure form. I don’t think those reasons are particularly powerful today. It is more about pure inertia.
Thus, I hew to the same position as Adam, but with one exception. I won’t even hold gold as jewelry.
Jeremy Siegel, in the sixth edition of his book Stocks for the Long Run, offers a graph depicting the real, after inflation, return of stocks, bonds, bills and gold from 1801 to 2021.
Over that 220-year stretch, gold closely tracked the inflation rate, offering little or no real return. According to Siegel, a one-dollar investment in gold in 1801 would have been worth $4.06 in 2021. That same dollar invested in stocks would have been worth $2,334,920. The lesson: while gold might protect your purchasing power over the long haul, it can’t be counted on to grow real wealth.
You could include an allocation to gold to reduce the volatility of your portfolio, but you probably shouldn’t count on it to make you richer.
A while back, I looked at what gold returned after the dollar was removed from the gold standard. In Aug, 1971, Nixon took us off the gold standard and into the fiat world we plunged. An ounce of gold was priced at $35 before the peg was removed. Here is what I found regarding the return of gold vs. the Dow.
Gold grew at an annualized rate of 7.73% from 1/1/1972 to 12/1/2023.
The Dow grew at an annualized rate of 7.4% from 1/1/1972 to 12/1/2023
The money supply has also grown substantially which, of course, devalues our dollars. Here’s what I found there:
M1 grew at an annual rate of 8.77% from 11-1-71 to 11-1-23 .
Thus, owning gold and stocks, over very long periods, can help defray the ravages of inflation and the Fed’s money printing machine.
Thanks for the excellent explanation of why gold prices have surged recently.
The old “no inherent value”/no inherent rate of return canard really does need to be retired. As other commenters have pointed out, assets denominated in fiat currencies also have no inherent value – unlike physical gold. But more to the point, gold’s value is in being a truly uncorrelated asset that, when held in judicious amounts, can buffer portfolios against sequence-of-returns risk.
This comprehensive post on the excellent Portfolio Charts site shows just what this means to real-world retirement portfolios not only in the U.S. but globally. The author points out that as a standalone investment gold is literally the worst of all possible choices – but that in the right amounts it is an invaluable if not essential component of the best-performing (on a risk-adjusted basis) portfolios:
https://portfoliocharts.com/2024/04/01/what-global-withdrawal-rates-teach-us-about-ideal-retirement-portfolios/
Gold’s positive is its long history of value particularly during times of “seeming” strife. I view it more as a hedged insurance policy rather than conventional financial investment. Thus, allocating a few percent to GLD, IAU or maybe even some jewelry seems fine for those seeking this kind of diversification.
Preppers sometimes view gold as cataclysmic insurance, but many have pointed out that water, food and ammo would be more important than gold with any ultimate calamity. Only “backyard gold” could help, but backyard gold has its own set of huge risks….and besides we’d run out of water and food before the gold could help.
The weakness in this article is this notion of intrinsic value. It is true that gold’s intrinsic value is hard to pin down, but what is the intrinsic value of a $50 bill? Intrinsically, nearly nothing, because aside from its symbolic value, it can’t be used for anything much useful. What is the intrinsic value of the the balance in your savings account? Even less, it is simply a digital representation, some electrons on a screen.
If you want to talk about the intrinsic value of things, then you are in the category of commodities, a bushel of wheat or a barrel of oil has intrinsic value. A tractor has intrinsic value because it is a productive asset that can achieve a wide variety of uses for the farmer.
Money does not have intrinsic value, it is a medium of exchange. Whether it is gold coins, mother-of-pearl, or paper with fancy symbols on it, it’s “value” is simply what somebody will exchange with you for it. In the case of gold, that is currently about $2200 USD per ounce. This is not as mysterious as it seems once one realizes it has nothing to do with intrinsic value.
As you note, intrinsic value is not dependent on whether or not the thing produces any income. Rather, intrinsic value is better defined as being: “… the value that that thing has “in itself,” or “for its own sake,..” You are also correct that paper currency (“fiat” money) has no intrinsic value. That said, unless we hold certain items in physical form, i.e., gold, bushels of wheat or tractors, their intrinsic value may be ephemeral. Also, in practical terms, its hard to get change for a bar of gold or a tractor.
On a more practical level, gold has occasionally been a good investment, but not necessarilly over a long period of time. And, when it does do well, our success as investors relies too much on accurate market timing.
While I understand the argument for gold, I personally would prefer to investment my money in something that produces a real return over time.
Adam, a thorough and altogether wonderful article about gold as an investment alternative. I learned a lot from it.
I remember Buffett once wrote about gold in one of his annual letters. He made the distinction between owning productive versus non-productive assets. Over very long periods gold has not grown as much as the stock market; but over shorter periods it has sometimes performed well. So it seems it might be useful for traders, but not long term buy and hold investors.
I was saddened to read that Daniel Kahneman recently passed away and Jason Zweig wrote an excellent article about him in the Wall Street Journal yesterday. Many remember him, along with his long time partner Amos Tversky as a pioneer in behavioral finance. I found his “Thinking Fast and Slow” to be a wonderful and readable introduction to how and why we make the decisions we do, not only in investing but in every day life. I’d love to read your thoughts about his work, and perhaps Jonathan’s too!